Investment is well diversified and the sector’s footprint is modest, supporting resilience
Nevertheless, some of their strategies could cause financial stability risks if they correlated with hedge funds in other countries that have similar exposures.
According to the report, relative value funds, which try to profit from price differences between similar assets, and credit funds, which focus on debt markets, need particular attention.
This is partly because they are operating in core markets where shocks can transmit directly into the real economy and the wider financial system, including the banks.
Irish hedge funds’ asset holdings are mainly with the US (45pc), EU (26pc) and UK (17pc). Their sovereign exposures are mostly to US treasuries, with a much smaller exposure to EU and UK government bonds.
Systemic vulnerabilities are not fixed – they evolve over time
Hedge funds are interlinked with a small number of international prime brokers – based in the US, UK and Switzerland – through borrowing and trading. “This suggests substantial concentration of derivative trading among a small number of intermediaries and could lead to spillovers to/from hedge funds in a shock,” the report says.
Investors in Irish hedge funds are quite diversified, with non-EU players holding most of the shares, generally through non-bank entities. Pension funds are a major investor.
“The sector is large, but diverse, and that diversity, in and of itself, supports resilience,” Vasileios Madouros, Central Bank deputy governor, said. “The market footprint of the Irish hedge fund sector is modest, limiting systemic impacts.”
In relation to hedge strategies that match funds in other jurisdictions, he said: “A key outcome of our work will be engagement with authorities internationally to deepen our collective assessment of the global non-bank sector.
“The insights from this work will also strengthen our ongoing surveillance of hedge funds, because systemic vulnerabilities are not fixed – they evolve over time.”
The Irish hedge fund sector appears resilient to one-off margin calls and redemption shocks
Ireland is among the largest domiciles for hedge funds in the world, with about 4pc of the global total and 60pc of euro-area assets in the sector.
Hedge funds, which are collective investments that generally seek out riskier undertakings, often go for high-leverage, highly concentrated exposures. This means that, in a market shock, they may have to unwind positions in a hurry and at reduced prices.
The Irish hedge fund sector appears resilient to one-off margin calls and redemption shocks, the Central Bank report finds, although pockets of vulnerability exist.
Hedge funds here mostly operate on a monthly dealing basis, or even less regularly. Almost 70pc of assets under management are in funds that offer only monthly, quarterly or yearly redemptions.
Daily dealing funds represent €104bn (26pc) of assets under management.
Credit funds and relative value funds exhibit higher liquidity shortfalls relative to others when a severe margin call or redemption shock scenario is applied, the report says.
“Hedge funds are playing an expanding role in sovereign bond markets, absorbing net supply, but raising concerns over the potential impact of a sudden withdrawal from the market,” it also warns.